Following the implementation of the movement control order (MCO), electronics manufacturing services (EMS) companies under our coverage have halted production and are currently awaiting clarification and approval from MITI to resume operations. The extension of the MCO period announced yesterday is likely to further lower their earnings. In view of the acceleration in the number of Covid-19 cases, deteriorating consumer sentiment and negative impact from the MCO, we cut their FY20-22E earnings by 9-22% and lower the target PER multiples for ATA and VS. We maintain our SELL calls on ATA and VS, and downgrade our rating on MTAG to SELL (from Hold), all with lower TPs. We maintain our Underweight stance on the EMS sector.

Temporary Production Halt - Pending Clarification on MCO

The Malaysian government has extended the MCO to 14 April (from 31 March previously) in view of the rising number of new cases of Covid-19 in Malaysia which prompted the government to believe that this trend may continue for a while before it reverses. EMS players under our coverage have halted their production since the implementation of the MCO on 18 March. While the government is allowing companies that are part of the supply chain of essential goods to continue production over the MCO period and has expanded the essential list to include certain products and services e.g. Electrical and Electronics (E&E), the EMS players are still awaiting the Ministry of International Trade and Industry’s (MITI) clarification and approval as it is not clear which part of E&E is allowed to operate.

Potential Adverse Impact on Earnings

A full 28-day factory closure is likely to negatively impact the EMS players’ earnings as they would continue to incur fixed costs such as rental and staff costs despite the temporary production halt. Even if they are allowed to resume production, they are required to operate at a minimal workforce (capped at 50%), according to National Security Council (NSC). This would result in lower production and adversely impact their earnings.

Not Spared From Global Economic Slowdown

We lowered our year-end FBMKLCI target to 1,200 on 16 March 2020 as we cut our GDP forecast to 3.3% for the year in our strategy report: A financial tsunami. In the note, we also downgraded the EMS sector to Underweight (from Overweight) as we lowered our earnings forecasts (by 16-36%) and target PER multiples. We believe the weak consumer sentiment and global economic slowdown are likely to dampen discretionary spending, and the EMS players are not likely to be spared as they are mainly involved in the manufacturing of consumer products such as household appliances, coffee machines and pool cleaners.

Second Major Earnings Forecast Cut; Maintain Underweight

In view of the accelerating number of Covid-19 cases globally, deteriorating consumer sentiment and extension of the MCO, we cut our earnings forecasts by another 9-22%, expecting a steep 36% decline in the sector’s 2020E core net profit. In addition to the cuts in earnings forecasts, we also lower our target 2020E PER multiple for ATA and VS to 10x, which is at the sector’s 13-year mean PER (since 2007). We maintain our SELL calls on ATA and VS with lower TPs of RM0.55 (from RM0.90) and RM0.60 (from RM0.85) respectively.

Source: Affin Hwang Research - 26 Mar 2020